Thoughts on the Market: Risks and Uncertainty in the Fed’s New Outlook

Podcast Information:

• Title: Thoughts on the Market
• Host/Author: Morgan Stanley
• Episode: Risks and Uncertainty in the Fed’s New Outlook
• Release Date: March 20, 2025

Introduction

In the March 20, 2025 episode of Thoughts on the Market, Morgan Stanley's Matthew Hornbach and Chief U.S. Economist Michael Gapen delve into the recent Federal Open Market Committee (FOMC) meeting. The discussion centers on the Federal Reserve's updated economic projections, the accompanying risks and uncertainties, and the implications for future monetary policy.

Federal Reserve's Updated Projections

Key Highlights:

• The Fed has aligned its projections more closely with Morgan Stanley's outlook, indicating a potential stagflation scenario with slower economic growth and persistently high inflation.
• There is significant policy uncertainty highlighted in the Fed’s updated projections.

Notable Quotes:

• Michael Gapen (00:26): “The Fed’s forecasts actually now look a lot like our outlook for the US Economy. So they revised down their expectation of growth, they revised up their expectation for inflation.”

Discussion: Michael Gapen emphasizes that the Fed's downgrading of growth expectations and upward revision of inflation forecasts align with Morgan Stanley's own economic outlook. This alignment suggests a shared view of a challenging economic environment characterized by sluggish growth and entrenched inflation rates.

Assessing Policy Uncertainty and Risks

Key Highlights:

• The Fed underscored high uncertainty regarding both inflation and economic growth.
• There are competing risks related to the Fed's dual mandate: inflation risks are skewed to the upside, while growth risks tilt to the downside.

Notable Quotes:

• Michael Gapen (01:45): “The Fed highlighted high policy uncertainty. They wrote down a forecast, but I'm not all that convinced that they have a lot of confidence in how things will evolve.”
• Gapen continues (02:15): “You have kind of competing risks here around the Fed’s dual mandate. They’ve got upside risk to inflation, downside risk to growth.”

Discussion: Gapen points out that the Fed's communication reveals a lack of confidence in the economic outlook, emphasizing the high uncertainty surrounding both inflation and growth. This dual uncertainty poses a complex challenge for the Fed's policy decisions, balancing inflation control with supporting economic growth.

Federal Reserve's Policy Response

Key Highlights:

• Fed Chair Jerome Powell suggests a cautious approach, potentially holding rates steady or considering cuts if economic conditions deteriorate.
• The Fed may overlook short-term inflationary pressures from tariffs but be prepared to ease policy if the economy weakens.

Notable Quotes:

• Michael Gapen (01:56): “Powell said we're either going to be on hold or we're going to be cutting rates. And generally I think that's the right thing.”

Discussion: Matthew Hornbach inquires about Powell’s stance on appropriate policy actions given the current uncertainties. Gapen interprets Powell's comments as signaling a possible pause in rate hikes or even rate cuts, depending on how economic indicators evolve. This cautious stance reflects the Fed's attempt to navigate the delicate balance between inflation control and economic support.

Market Expectations vs. Fed Projections

Key Highlights:

• The market currently prices in more rate cuts for 2026 than for 2025, partially aligning with Morgan Stanley's outlook.
• There exists a discrepancy between the market's average pricing of outcomes and Morgan Stanley's expectations.

Notable Quotes:

• Matthew Hornbach (03:50): “The market hasn't fully priced in the risk premia that the Fed might need to cut rates more aggressively.”

Discussion: Hornbach and Gapen discuss the divergence between market expectations and Morgan Stanley's projections. While the market anticipates rate cuts extending into 2026, Morgan Stanley believes cuts may be more delayed and heavily data-dependent. This difference underscores the complexity of forecasting in an environment riddled with uncertainties.

Impact on Equity Markets

Key Highlights:

• A significant decline in equity markets could influence Fed policy by affecting household wealth and consumer behavior.
• The Fed and Morgan Stanley are cautious about equity market volatility and its potential spillover effects on the broader economy.

Notable Quotes:

• Michael Gapen (05:22): “We would need about a 30% decline in equity markets before that spillover risk gets very elevated.”

Discussion: The conversation touches on the potential ramifications of a major equity market downturn. Gapen suggests that while a 10% decline is relatively routine, a more substantial 30% drop could pose significant risks to economic stability by impacting consumer wealth and spending. This perspective highlights the interconnectedness of financial markets and economic policy.

Looking Forward: Focus on U.S. Trade Policy

Key Highlights:

• Investors are keenly watching for developments in U.S. trade policy, particularly the Trump administration's plan for reciprocal tariffs slated for April 2nd.
• Anticipation of policy announcements and their implications for the economy over the next several years is a central concern.

Notable Quotes:

• Matthew Hornbach (06:52): “Clients are very focused on April 2nd. There's a crescendo in concern, perhaps over what will come of US Trade policy for the balance of this year and really for the balance of the next three and a half years.”

Discussion: The impending announcement of reciprocal tariffs by the Trump administration is a focal point for investors. The uncertainty surrounding which tariffs will be implemented and their long-term impact on trade relations and economic growth is generating heightened attention and concern among market participants.

Conclusion

The episode effectively captures the current economic landscape marked by high uncertainty and competing risks related to inflation and growth. Morgan Stanley's Matthew Hornbach and Michael Gapen provide insightful analysis into the Fed's cautious approach, the disparity between market expectations and their projections, and the potential impact of U.S. trade policies on future economic conditions. As the Fed navigates these complex dynamics, investors remain attentive to policy developments and market indicators that will shape the trajectory of the U.S. economy in the coming years.

Notable Quotes Summary:

• Michael Gapen (00:26): Highlights alignment between Fed projections and Morgan Stanley’s outlook.
• Gapen (01:45): Emphasizes high policy uncertainty and competing risks.
• Gapen (01:56): Discusses potential Fed policy actions of holding or cutting rates.
• Matthew Hornbach (03:50): Notes market’s pricing in additional rate cuts beyond Morgan Stanley’s expectations.
• Gapen (05:22): States that a 30% equity decline would significantly elevate spillover risks.
• Hornbach (06:52): Points to investor focus on impending U.S. trade policy decisions.

This comprehensive summary encapsulates the key discussions and insights from the episode, providing valuable context and analysis for those seeking to understand the current market dynamics and Federal Reserve outlook.